PERSPECTIVES

Our managing
editor, Darcy Olsen, has been kicked upstairs so to
speak. She has taken the position of Entitlements Policy
Analyst here at Cato. Congratulations and thanks for your
work on Regulation.

Taking over as
managing editor is Ricardo Reyes. Ricardo has a B.A. from
Rice University. He has worked as an election observer
for the International Republican Institute, assigned to
Nicaragua, his homeland, writing reports in both English
and Spanish on democracy, development, and the like. He
also did a stint at the Jefferson Group and the
Leadership Institute. Welcome aboard!

Antitrust laws
purport to prevent monopolies and encourage competition.
Yet since their advent in 1890, they have done little
more than provide undue government support for
politically powerful sectors and enterprises and give
government operatives a kind of monopoly power that they
exercise according to whatever arbitrary standard suits
them at the moment. In 1962, Alan Greenspan wrote that
antitrust was:

a world in
which competition is lauded as the basic axiom
and guiding principle, yet "too much"
competition is condemned as
"cutthroat." It is a world in which
actions designed to limit competition are branded
as criminal when taken by businessmen, yet
praised as "enlightened" when taken by
the government. It is a world in which the law is
so vague that businessmen have no way of knowing
whether specific actions will be declared illegal
until they hear the judges
verdictafter the fact.

The Clinton
administration not only stuck with that tradition, it has
also refined it to help further intrench government in
business practices.

Delegating
Power

The vague and
sweeping nature of antitrust laws exemplifies the
delegation problem. Contrary to the letter and intent of
the Constitution, today the executive branch, not
Congress, makes many of the laws in this country.
Congress simply delegates open-ended authority to the
executive which acts as it wills. When administrations
change, policies can change dramatically. During her
tenure, the Clinton administrations recently
departed Deputy Attorney General for Antitrust, Anne
Bingaman, pursued many cases that Reagan administration
officials would not have touched.

Arbitrary
Standards

Antitrust laws are,
by nature, arbitrary. The actions of Clintons
Federal Trade Commission to block the merger of two
office supply retailers, Office Depot and Staples, are a
case in point. Those two enterprises account for only 4
percent of office supply sales. But using calculations
akin to alchemy, the FTC argued that the two account for
almost all of the sales by enterprises of their size. In
other words, depending on how bureaucrats define a
particular sector, they can declare anything a monopoly.
Never mind that customers can get the same products in
other stores. The stores are not as large.

The
administrations vendetta against Microsoft also
points out the arbitrary nature of antitrust. Bingaman
threatened to stop release of the Windows 95 software
because the company planned to create the Microsoft
Network (MSN), an Internet service provider to compete
with America Online, Compuserve, and other providers.
Before the release of Windows 95, it was known that the
software would automatically place an icon on the
personal computer users desktop each time the
machine was turned on. The icon would allow access to MSN
with a single click of the mouse. Critics suggested the
icon would offer personal computer users an unfair
incentive to subscribe to MSN.

But Windows 95
allows a user to put the icon for any competing system
permanently on the machines desktop, with three or
four clicks of the mouse. Whenever the PC is switched on,
the icon for the competing Internet service provider will
appear and can be accessed with a single mouse click.
Perhaps neither Bingaman nor her staff had ever been
on-line. Fortunately they didnt act against
Microsoft in that case. But the fact that they could make
such threats indicates the problem with the current
system.

Extraterritorial
Regulations

A small but very
dangerous trend that started under George Bushs
re-regulation binge continued under Clinton; the practice
of exporting Americas bad policies, colluding with
other governments to internationalize bad regulations. A
case in point was the Antitrust Divisions action
against several Japanese fax paper manufacturers. Those
firms were engaging in pricing practices in Japan that
are perfectly legal in that country. They also sold paper
to unaffiliated distributors who marketed the products in
the United States. The administration went to court to
stop the practice of those Japanese firms operating in
Japan.

But consider the
implications of that principle. Ford Motors operates
plants in Germany that are subject to German labor laws.
It also operates American facilities that are subject to
American labor laws. Germany could consider the situation
"unfair." Since Americas labor laws are
not as restrictive as Germanys, that country is at
a competitive disadvantage. (That explains in part why
German auto companies are building factories in Alabama
and South Carolina rather than in the Rhineland or
Schleswig-Holstein.) Thus Germany, operating on
Americas extraterritoriality principle, might sue
Ford in Germany because Ford plants in America do not
offer forty days of paid vacation and other benefits that
are driving down Germanys economy.

Trusting
Markets

If ever there was a
time to question the need for antitrust laws, it is now.
Global markets are much more integrated today than ever
before. Average tariffs have dropped from around 40
percent after World War II to around 3 percent today.
Transpor-tation costs over the past two decades have
dropped significantly. Asian, Latin American, and
formerly communist countries compete in the global
market. The production process it-self is a global
affair. Few products are made completely in one country.
In short, there is no lack of competition.

Further,
technological change is swifter than ever.
Com-munications is becoming more integrated. Broadcasting
competes with microwaves, cable, and satellites. New
technologies, such as digital compression, allow for
better use of resources.

Those facts are
prima facia arguments against the need for Justice
Department and FTC antitrust activities. It is not time
to reform antitrust, or for governments to
"manage" deregulation of telecommunications,
electricity distribution, or any other sectors. It is
time to trust markets, not governments.

Edward Hudgins

Editor of
Regulation and director of regulatory studies at the Cato
Institute

Under Executive
Order No. 12866, all federal agencies must submit
proposed regulations to the Office of Management and
Budget for review ninety days prior to their publication
in the Federal Register. Among other things, the OMB is
required to analyze the economic impact of new
regulations and determine whether they comply with
federal guidelines. Supposedly the review is independent
and objective, much like a non-binding audit. The OMB
acts as a traffic cop, ensuring that regulatory agencies
do not publish rules before they have been properly
analyzed. However, should a regulatory agency exercise
undue influence over the OMB, the review would be little
more than a rubber stamp for agency proposals.

The Environmental
Protection Agencys efforts to squelch
intra-administration criticism of its recent air quality
proposals suggests manipulation of executive oversight is
underway.

Oppressive
Air Standards

The Clean Air Act
of 1970 requires the EPA to set federal air quality
standards for every city in the nation. States must
ensure that all cities meet the standards or possibly
lose federal highway funds and face other federal
sanctions. Last November, the EPA proposed tightening the
air quality standards for ozone and particulates,
arguably the most controversial proposal in the
EPAs history. Even environmental stalwarts such as
Senator John Chafee (R-R.I.) have openly questioned the
proposed standards.

The EPAs
proposal is controversial in part because it will more
than double the number of cities out of compliance with
federal air quality standards, triggering costly
regulations on consumers, automobile owners, and small
companies. For example, cities failing to meet the new
standard could be required to impose new automobile
emission inspection programs; promote the use of
alternative fuels; and encourage "transportation
control measures" (a euphemism for car pooling).
Were that not bad enough, the EPA has failed to prove
that tightening air quality standards will improve the
protection of public health at all.

Congressional
Concern

Congressional
leaders from both parties have expressed concern about
the proposed standards. Last December, House Commerce
Committee Chairman Thomas Bliley (R-Va.) wrote to OMB
officials asking their opinion of the EPAs rules.
He wanted to know whether the EPA had complied with
federal guidelines in drafting the regulations. The
OMBs response was vague and scarcely informative.
It almost read as if the EPA had drafted the letter
itself.

Recently released
documents suggest the EPA may effectively have done just
that. In January of this year, Bliley asked EPA officials
about their involvement in the OMBs response to his
December request. Assistant EPA Administrator for Air and
Radiation Mary Nichols replied that the OMB had asked her
agency for its response to Blileys inquiries and
that the agency had sent one along.

But internal
memoranda between the two agencies, leaked just after
Nichols initial response, revealed that EPA
officials censored OMB criticism of the air quality rules
in an effort to mute public criticism of the standards.
The EPA even proposed to revise the OMBs response
"line by line." According to a memo from Deputy
EPA Administrator John Beale, the OMBs first draft
of the Bliley letter needed editing because, "As
written, the OMBs response could be very
damaging." Beale was concerned that the OMB would
tell Congress that the EPA did not examine the impact of
its own proposed rules adequately.

After the leaking
of the internal memoranda, the OMBs original draft
letter for Bliley surfaced. It stated that the EPAs
economic analyses, "did not fully conform" with
current federal guidelines. In particular, the EPA did
not fully examine the costs of its proposal and had been
unable to identify how many regions of the country would
ever comply with existing air quality standards, let
alone tighter ones.

Curiously, despite
Blileys specific request that the EPA identify all
officials that reviewed the OMBs response, Nichols
made no mention of the Beale memo in her response
concerning the preparation of the original response to
his December inquiries. According to Nichols, the draft
of the OMB letter, which had been faxed directly to
Beale, had been "inadvertently overlooked."

Ignoring
Health Risks

The Clean Air Act
explicitly requires that the EPA set standards based upon
"all identifiable effects on public health or
welfare." However, the Agency ignored its own
findings that reductions in tropospheric ozone (the goal
of its proposed new clean air standards) could lead to an
increase in ultraviolet-B (UV-B) radiation. According to
prior EPA findings, even marginal increases in UV-B
exposure are cause for concern, hence the Agencys
zealous efforts to phase out all substances suspected of
damaging the stratospheric ozone layer. Translation: The
proposed new legislation could actually endanger public
health. Whether the EPAs concerns about UV-B are
overstated or not, it is troubling that the Agency
cavalierly discarded its own scientific claims when
regulating something else.

OMB analysts
Randall Lutter and Christopher Wolz, in an article
published recently in Environmental Science &
Technology, maintained that increased UV-B exposure
caused by the EPAs proposed rules could result in
as much as $1.1 billion in health costs from the
regulation itself. Yet when the OMB raised those
concerns, the EPA would hear nothing of it.

EPA
Strong-arm Tactics

Shortly after
Bliley received the EPA-OMB correspondence, other
agencies expressed unanimity with OMB concerns. Officials
from several departments and executive agencies expressed
concerns about the aggressiveness of the EPAs
proposal, its exorbitant costs and the lack of sufficient
interagency review. Yet the EPA neglected to include
those concerns in the regulatory docket for the proposed
rule.

A week before the
regulations were released, White House Science Adviser
John Gibbons wrote in a memo, "I find it hard to
believe that we would suffer more than we would gain by
taking more timeeven sixty daysfor further
inter-agency review, consensus building, and additional
analysis." Gibbons noted that "questions remain
about the appropriate level and the significance of the
health effects that might be avoided" by tightening
federal air quality standards.

Shortly after the
rules were issued, Alicia Munnell of the Presidents
Council on Economic Advisers commented internally that
the EPAs analysis "understates the true costs
of the stricter standards by orders of magnitude."

A significant
portion of the new air quality standards burden will fall
on small businesses. Most large industrial emission
sources are already subject to strict regulatory
controls. Thus Small Business Administration counsel Jere
Glover wrote in a memo to EPA administrator Carol
Browner, "This regulation is certainly one of the
most expensive regulations, if not the most expensive
regulation, faced by small businesses in ten or more
years." Regardless, the EPA asserted in the Federal
Register that the new standards "will not have a
significant economic impact on a substantial number of
small entities . . ." The agency claimed that it was
unable to perform the analyses required under the
Regulatory Flexibility Act to certify that proposed
regulations achieve their goals placing as little burden
on small enterprises as possible. Centralized executive
review is designed to catch that type of regulatory
indiscretion.

Reviewing
Review Integrity

Recent regulatory
reform efforts have focused on establishing new review
requirements for federal agencies. Legislative proposals
have sought to establish guidelines for risk assessments
and cost-benefit analyses that would apply to all federal
rule-making. Such reforms will only be effective if the
OMB maintains its independence. Emasculate the OMBs
ability to rein in regulators, and no set of analytical
review requirements will restrain the bureaucratic urge
to regulate.

If the review
(rather, lack thereof) of the EPAs latest air
quality proposal is any indication of current trends,
executive oversight is an increasingly ineffective means
of curbing regulatory excess. For regulatory reforms to
be successful, they will have to directly challenge the
prerogative of regulatory agencies to set their own
agendas. Ending the delegation of rulemaking authority
and requiring Congress to explicitly authorize
substantive regulatory enactments is the surest way to
achieve that end. Most other types of regulatory
"reform" will fail.

A few years ago,
politicians alleged that they had discovered fraud and
cheating in biomedical science. They marshaled the forces
of the United States Government to expose the chicanery
and, as a byproduct, intentional or accidental, dragged
science and scientists down into the muck of politics.
Those bureaucratic efforts have tarnished reputations and
cost millions of dollars. Worse, they perpetuate the idea
that science tolerates cheating and fraud that only a
government-funded "fraud squad" can root out.
To use a Mencken-favored word, its hooey.

One episode began
in 1986 when Thereza Imanishi Kari, an immunologist at
MIT, David Baltimore, a Nobel Laureate also at MIT, and
four other scientists published a paper in the
prestigious journal Cell. Subsequently, a
researcher in Imanishi Karis laboratory challenged
the validity of her data. Review panels at MIT and Tufts,
where Imanishi Kari moved after MIT, investigated the
charges. Both panels dismissed them. In 1989, The
National Institute of Health (NIH) also investigated the
charges. The NIH found no evidence of fraud but required
Imanishi Kari, Baltimore, and the others to publish
corrections of some disputed data. A year later, NIH cut
off Imanishi Karis research funding. The private
American Cancer Society continued funding her research.

To that point, the
science community had dealt with the dilemma internally.
That ended in 1989, when Representative John Dingell
(D-Mich.), then the powerful chairman of the House
Committee on Energy and Commerce, jumped into the
"Baltimore affair." In a hearing that year, he
attacked Imanishi Karis honesty and intentions.
Dingell, notorious for his bullying tactics, may have
been surprised at what happened next. Baltimore had the
temerity to defend his colleague and to criticize
Dingells meddling. Perhaps angered or annoyed,
Dingell initiated a Secret Service forensic investigation
of Imanishi Karis lab books. Then the second major
player, the NIHs Office of Research Integrity (ORI)
got into the act. Based on the Secret Service
investigation, ORI concluded that Imanishi Kari had
fabricated her data. In 1994, ORI recommended that she be
barred from receiving federal research funding for ten
years.

Imanishi Kari
appealed the decision. The Department of Health and Human
Services (HHS) appointed an adjudication panel that held
six weeks of hearings in the summer of 1995. After
questioning Imanishi Kari and ORI, the panel concluded
that ORI had presented irrelevant information "based
on unwarranted assumptions." The panel dismissed all
the charges against Imanishi Kari.

The Imanishi Kari
case is not the only example of zealous investigations
and attacks that have come to naught. HHS investigators
combed through the lab notebooks of Dr. Robert Gallo, the
co-discoverer of the AIDS virus. After much damaging
publicity to Gallo, the HHS concluded Gallo had been
guilty of "minor misconduct." An appeals panel
rejected the decision.

In 1994, Dingell
attacked Dr. Bernard Fisher, a cancer researcher at the
University of Pittsburgh. Subsequently, the National
Cancer Institute removed Fisher from the directorship of
an extensive breast cancer treatment study and labeled
papers hed written fraudulent. To its credit, the
ORI exonerated Fisher in March of this year, saying that
there was no evidence of misconduct.

Earlier this year, Science
magazine summarized the track record of the thirty-nine
person, $3.8 million-per-year ORI. Since 1992, it has
received more than fifteen hundred allegations of
misconduct, finding seventy-four scientists guilty.

Students and
technicians are the targets of about one third of
ORIs investigations, but they comprise more than
half of ORIs "victories." And we can
expect ORI to focus more and more on those with small
budgets. After the appeals panel reversal of ORIs
decision in the Imanishi Kari case last summer, ORI
dropped misconduct charges against three other scientists
who were represented by her lawyer.

ORI should be
closed. It does little to no good but much harm. It has a
miserable track record. But those are not the reasons for
closing it. The reason is that ORI is unnecessary.

Science functions
at the frontier of human knowledge. Nobel Laureate Albert
Szent Gyorgyi, discoverer of the structure of Vitamin C
and arguably the most personable Hungarian biochemist who
ever lived, said, "Discovery is to see what everyone
else has seen and think what nobody has thought."
Peter Medavar, another Nobel Laureate, likened the
formulation of a new scientific theory to the creativity
that goes into composing a symphony, writing a novel, or
painting a portrait. But science doesnt end with
ideas or theories. Progress comes from experimentation.

Does the theory
predict, describe, and encompass the way some part of the
physical world behaves? And fundamentally, is it possible
to test the theory?

The physicist Paul
Davies said, "A theory that is too vague or general,
or makes predictions concerning only circumstances beyond
our ability to test, is of little value." Scientists
make mistakes. Their theories can be wrong, their tests
can be inappropriate or poorly done, their
interpretations of test results can be off the mark. Such
mistakes are so much a part of science that a section of
a new book about the origins of molecular biology is
titled "Misinterpretations."

Mistakes, painful
as they are to those who make them, are honest. The same
testing that reveals mistakes will catch cheating and
fraud. Cheaters pay the price. They are ostracized, their
ideas discounted, their results doubted, their
publications taken with a grain of salt. Fraudulent
science provides no foundation for work by other
scientists, it is properly tossed aside along with the
scientists responsible for it.

Chris Pascal, the
lawyer who directs ORI, argues that ORI preserves the
confidence of scientists, Congress, and the public. Yet
its record of overturned rulings and its targeting of
those least able to defend themselves does not reassure.
Scientists themselves have the most to gain from
preserving the publics confidence in science. They
can accomplish that by being skeptical, testing each
others ideas, and validating or falsifying each
others results. A fraud squad, even one with the
Orwellian title "Office of Research Integrity,"
is unnecessary. Congress should close it down.

The Superfund
program was established in 1980 to clean up hazardous
waste dumps. Since its inception, the program has spent
some $40 billion from general federal revenues as well as
from a special tax on the chemical and petroleum
industries. Senator Bob Smith (R-N.H.), Chairman of the
Superfund Subcommittee of the Committee on the
Environment and Public Works, recently endorsed the
comment of an unnamed former EPA administrator who said
that Superfund is, "the worst program ever enacted
by the U.S. Congress." He announced an intent to
"restructure the program from top to bottom."
To that end, he introduced the Superfund Cleanup
Acceleration Act of 1997 (S. 8). Unfortunately, while the
bill will provide some relief from some of the laws
worst provisions, Superfund is fundamentally defective.
Even a far more radical "restructuring" than
S.8 would be of only minor use. The program needs to be
uprooted.

Fundamental
Flaws

For the entire
seventeen years of its operation, the Superfund
programs basic flaws have been evident. First, the
program imposes liability for cleaning up hazardous
substances on everyone connected with the pollution,
including the generators of the alleged pollutants, the
transporters, and the landowners. It even extends
liability to parties who lent money and became active in
the affairs of the borrower. Further, Superfund makes
liability retroactive for events that occurred before the
law establishing the program was passed.

A second major
problem with Superfund is that liability is strict. It
does not distinguish according to amount of waste. The
rule of joint and several liability applies. A party that
discards one pound of waste in a dump the size of
Manhattan could be billed for the cost of cleaning up the
entire dump. The liability extends to individuals who
have their waste picked up by municipal trash haulers,
who in turn dispose it as directed by local public
officials.

Third, cleanup
standards are absurdly stringent. Congresss
preference for "permanent" solutions has been
interpreted as requiring cleanup rather than containment,
regardless of cost or benefit. Future use of the land and
the economic value of the property are not taken into
account in the decision. Thus it might cost $30 million
(the average price of cleaning up a major site) to clean
up a piece of property in an old industrial park to
residential standards even though the property will
simply be used as another industrial park in the future.
To compound the problem, "worst first" decrees
require restoration of the most polluted sites before
restoration of sites that might be made usable again with
minimal expenditures.

High transaction
costs is a fourth costly effect of Superfund. At least 30
percent of Superfund expenditures from government and
businesses are spent on the legal process, not on
clean-up. Because of the high stakes, companies have
strong incentives to challenge Superfund efforts. The
fees of lawyers and consultants mount. For most sites,
cleanup costs are divided according to complicated
multi-factor equitable tests that invite wrangling.

Since everyone who
ever used the site is liable, the number of parties
brought into the game expands. The EPA sued eleven
companies who in turn brought in 180 more, and those
added another 590. Swept up in the last tier was the
owner of a diner who swore her contribution consisted
solely of mashed potatoes and similar restaurant waste.
Her story is distressingly typical.

The EPA blames the
corporations for such abuses. That defense misses a
fundamental point. It is the statute, written by Congress
with help from the EPA, that makes the restaurant-owner
liable. The Agencys desire to keep everyone legally
responsible and then exercise complete discretion to
decide who actually pays makes the whole situation worse,
not better.

Lastly, the scope
of Superfunds coverage is unmanageable. EPA has
designated about 1,250 sites on its National Priorities
List (NPL). Those are the only sites in which EPA is
directly involved. Yet another thirty-thousand sites,
rejected for inclusion in the NPL, are still covered by
the basic Superfund liability laws. They can be the
subject of private law suits. States have created their
own programs that address tens of thousands more sites.
In fact, every site where any amount of chemicals has
been leaked, spilled, or dumped is covered by Superfund.
The total must run into the hundreds of thousands, maybe
the millions. Most could be cleaned up with minimal
effort. But the program pressures new industries to head
for the suburbs, for the "greenfields," rather
than to redevelop old urban industrial plots, usually
referred to as "brownfields."

Reform
Efforts

S. 8 attempts to
alleviate Superfunds most obvious defects. First,
it would exempt some future innocent purchasers of
property from Superfund liability. Further, for NPL
sites, it would eliminate the liability of minor parties,
small businesses, and municipalities.

Second, S. 8
reforms the cleanup standards, potentially allowing
containment rather than complete clean-up at some sites.
Specifically, EPA risk assessments would be required to
consider the future uses of the land when deciding
between clean-up or containment. Skeptics might question
the extent of sound judgement EPA will exercise in making
those evaluations. But at least the reform would prevent
EPA from claiming that the statutes preclude more
economically responsible options.

Third, S. 8
replaces the judicial process of allocating costs among
the parties with an administrative one. But the standards
remain amorphous, and it is not clear whether bureaucrats
would do a fairer job than judges in making such
decisions.

S. 8 further makes
a bow towards federalism, giving the states some
decision-making authority over NPL sites. But that
devolution is really a Potemkin Village. States must ask
for EPAs approval of their decisions every step of
the way.

S. 8 deals with the
brownfields problem in a manner all too common for
government. Rather than eliminating economically
destructive regulations, the bill creates a $40 million
slush fund to be doled out to states and cities for
cleanup. Further, the funds will be doled out only after
a detailed process of planning and review, wasting
significant amounts of money along the way.

But the same
question EPA asks concerning Superfund sites, (Should
they be contained or eliminated completely?) should be
asked of the Superfund program itself. S. 8 merely tries
to contain a bad program. But its toxic effects on the
economy necessitate its elimination.

First, disposal of
hazardous waste is simply not a federal problem. Sites
are in particular states and should be the responsibility
of those states. A federal response capability for
certain kinds of emergencies might be defended on the
grounds of the economies of scale involved. Or, if waste
is dumped in a river, then some form of interstate and
thus, perhaps, federal action might be needed. Even in
such cases caution is necessary. Interstate groundwater
contamination is often used as the excuse for federal
intrusion, but the documentation of serious problems in
that area is exceedingly thin. Most waste goes into the
ground, where it just sits. Its effects are not
interstate and offer no grounds for federal involvement.

A second major
shortcoming of S. 8 is that it applies principally to NPL
sites in which the EPA is directly involved, not to other
sites that are still covered by Superfund regulations.
Private suits are still permissible under the
programs complex rules and other costly actions
could still be required.

A third problem
with the legislation is that it leaves a huge loophole
that could negate reform attempts. S. 8 requires EPA risk
assessment studies to consider future uses of land.
Agreed, future use of land must be taken into account,
but the cost of cleanup should drive the land-use
decisions, not vice versa. Herein lies the problem: the
EPA can predict any pollyannaish uses for the land they
choose. A site to be used as waste dump needs not meet
the same standards that might be appropriate for a
kindergarten.

Though
well-meaning, S. 8 merely takes a few shovelfulls of
sludge from a toxic program that cannot be reclaimed. The
debate should be not over how to reform Superfund but,
rather, over how to eliminate it.

The American
Legislative Exchange Council (ALEC) has issued model
legislation for injecting competition into the $208
billion American electricity monopoly. Todays
regulated system is responsible for wide price
disparities across regions. In the U.S., the average cost
of electricity is 6.89 cents/kilowatt-hour. Regional
prices range from an average of 10.27 in New England to
5.07 in the some Southern states.

ALEC, a non-profit
organization, promotes market principles through
dialogues between state legislators and members of the
private sector. Regrettably, it endorses the dominant
approach to deregulating electricity, an overly
regulatory contrivance known as "mandatory open
access." Under that approach, utilities would be
required to wheel competitors power to homes and
businesses over their own lines, at regulated rates. ALEC
continues to operate within the bounds of todays
short-sighted debate, missing a grand opportunity to lend
considerable clout to a principled case for total
electricity deregulation.

Regulating
Competition

The crux of
ALECs reform bill, like other market proposals,
states that electricity generation "should become
fully competitive, while the provision of transmission
and distribution should accomplish the triple objectives
of open access, comparability of service for all users,
and nondiscriminatory pricing." Under their plan,
state utility commissions would heavily manage future
competition, to the detriment of market innovations that
would otherwise emerge. ALEC insists that the commissions
will set regulations that "enhance reliability,
compensate transmission owners fairly, allow for widest
possible markets, and relieve transmission
congestion." Unfortunately, those goals necessitate
the same kind of price regulation that has failed in the
field of generation and would threaten electricity
markets with irreparable harm.

The open access
approach requires transmission owners to forfeit rights
over their transmission hardware and perform power-flow
management services for all those who inject uninvited
power into the grid. The market conditions that ALEC
believes can be established through regulations will be
at least unstable, if not impossible. In embracing this
regulatory paradigm, ALEC overlooks the route to
permanent, successful reform. Historically, exclusive
transmission and delivery franchises established by
governments and based on "certificates of
convenience and necessity," have stood between
suppliers and customers. To establish free markets, these
barriers simply should be Removed. The fact that open
access leaves delivery franchise intact will distort
markets for years to come and make full deregulation
harder to accomplish later.

Missed
Market Opportunities

True deregulation
of electricity at all levels will lead to innovation in
electricity generation and transmission, greater
reliability and falling prices. For example, multiple
rights-of-way into consumers homes already exist.
Those could be exploited by competitors simply by
removing utilities monopoly status. Cable,
telephone, and Internet companies currently seeking ways
to expand into homes could form competitive alliances
with electricity providers and real estate developers if
regulatory barriers protecting utilities were removed.

By establishing
Independent System Operators to micromanage the grid,
open access regulations may delay competitive pressures
that would promote full exploitation of new transmission
technologies. Silicon power-switching technology now
exists, permitting control of heretofore uncontrollably
high voltage power flows by allowing a given transmission
wire to handle more current. That technology would be
optimally exploited in the face of true competition that
would allow, indeed require, utilities and newcomers to
control megawatts on the grid the same way Intel
manipulates microwatts in a Pentium.

Also, companies
such as Allison Engine and Capstone Turbine are
developing microgeneration technologies that, in the
extreme, would eliminate the need for transmission
altogether. Business establishments and even homes could
have their own generators. The generators run on natural
gas, a network with infrastructure already in place that
can compete with existing transmission grids. But under
the current regime or the one proposed by ALEC there is
little incentive for newcomers to adopt such advances.
They can simply dump power into the grid.

Imposed
Obligations

A number of
provisions of the model bill secure
"cooperation" through mandates rather than
markets.

Obligation
to Connect:
In the early days, utilities themselves sought to
maintain their legal monopoly status. Thus, they could
not object too loudly to the traditional "obligation
to serve" mandate. Moreover, in a regulated regime
with monopolies using cost-plus-profit pricing, extending
electricity distribution to distant environs was an easy
way to overcapitalize the system and pass the costs on to
consumers, thereby maintaining hefty profits. Now,
however, the pressure group pendulum has swung to the
low-cost utilities and industrial users seeking open
access. ALEC obliges them by replacing "obligation
to serve" with "obligation to connect." In
a genuine, non-monopoly market, if a user seeks cheaper
power, he has every right and opportunity to cut deals.
But obtaining power is a customers problem. An
"obligation to connect" simply gives the
customer a special right and necessitates government
bureaucracies to enforce that right.

Mandatory
Unbundling of Services: ALEC would require
utilities to "operationally and/or financially
separate electric generation, transmission, and
distributions assets." But bundling ones
services and offering them at special prices is a
perfectly legitimate business practice; failing to
unbundle violates no ones rights. In fact, every
product with multiple features is bundled. Treating
electricity differently is arbitrary.

Mandatory
Filing of Plans: Under the ALEC proposal,
utilities are required to file their plans for open
access implementation with regulators. If there were no
options for utilities other than to remain insulated
monopolies, perhaps oversight would be appropriate. But
with deregulation, businesses should not need to report
to commissions. Businesses should be allowed to answer
only to customers.

Programmed
Competition

ALECs model
bill uses a number of statist devices that are unlikely
to lead to truly free markets.

Price
Controls:
The ALEC proposal dictates that transmitting utilities
must charge "just and reasonable"
non-discriminatory rates. Yet innovation on the grid is
at least as important as innovation in generation.
Fostering innovation sometimes requires pricing
discrimination for access, for example, to relieve
bottlenecks. Under the ALEC plan, state and federal
regulators would share jurisdiction over monopoly
transmission pricing, leaving no leeway for market
pricing of services.

Regulating
"Market Power": ALEC notes that "The
determination of corporate structure, excluding market
power issues, should be left to the marketplace and not
dictated by the government." However, state
commissions will "mitigate concentrations of undue
market power." But if competition is allowed, for
example, from out-of-state suppliers, there need not be a
concern over market power in transmission.

Regulating
"Safety and Reliability:" The ALEC model bill gives
state and federal regulators authority to guarantee
"safety and reliability" of the electrical
system. But the present system has proven itself
unreliable. A single line failure can cascade down the
system, causing blackouts for thousands or millions of
customers. Silicon chip-switching technology could reduce
such failures but the open access mandates remove many
incentives for implementation of that technology.
Further, without profits tied directly to service as they
would be in a more competitive market, providers have
less incentive to take greater care about reliability.
Reliability must be a competitive feature.

Subsidizing
Stranded Costs: The ALEC proposal grants
utilities the right to recover "prudently incurred,
net, verifiable stranded costs." Among the questions
raised by that approach is what to do with the stranded
asset. Can the utility collect stranded cost dollars and
still sell the electricity? Should the utility be allowed
to use recovery funds to launch unrelated ventures? Or
should it be required to transfer the funds directly to
the shareholders it is purportedly trying to protect? To
its credit, ALEC leaves most of those decisions up to the
states and limits the time for recovery.

Saving
Graces

Happily, some
recommendations in the ALEC bill are sound.

Ending
Public Power: ALEC correctly notes that
public and investor-owned utilities should face the same
legal, regulatory, and tax treatments and that
preferential subsidies must end. In principle at least,
that embraces the demise of public power and of
administrations that market federal power, thereby
obstructing competitive markets.

Delegitimizing
Franchises:
ALEC also observes that the law of eminent domain was not
intended to protect the utility but to protect the public
interest when it declared, "the right of eminent
domain shall not be used to restrict the construction of
new transmission or distribution facilities by any
qualified party . . . or otherwise limit
competition." Unfortunately, the bill would not end
the current franchise system, a necessary step in making
such construction commonplace.

Ending
Hidden Support of Renewable Energies: ALEC wisely argues that the
energy market ought not be exploited as a vehicle to meet
other, often questionable, social and environmental
goals. The costs for such programs should not be hidden
in electricity rates and borne by unwitting electricity
users.

Partial
Protection of New Markets and Innovations: Despite the unwarranted
concession to stranded costs, the bill rightly disallows
recovery of stranded costs for the increased usage of
self-generation or co-generation. Though the model bill
artificially bolsters central generation through open
access, at least it prevents existing utilities from
directly punishing others use of new technologies
with the stranded cost mallet.

Sunsets
Transmission Deregulation: The bill sunsets all
regulation of the electric power grid after ten years.
While there is no more worthy goal, it is flatly
contradicted by ALECs embrace of open access, which
cannot operate without regulation.

Limited
Liability for Unchosen Obligations: ALEC rightly assures that
distribution utilities forced to wheel power are not held
liable for errors of the generation supplier or other
parties not within their control.

Acknowledgment
of Federal Role: Despite its emphasis on
state reforms, ALEC also wisely notes that federal
reforms are necessary for full competition. Repealing the
Public Utility Holding Company Act and the Public
Utilities Regulatory Policies Act are specifically noted,
but a federal role in ensuring that states not impede
interstate commerce to protect local utilities will also
exist under a complete proposal.

No
Independent System Operator Mandate: The inherently political,
inherently monopolistic "independent system
operators" proposed by most reformers to manage open
access on a national scale will face political rather
than profit motives. They will also serve as a ready
scapegoat for service failures. ALEC does not explicitly
recommend the creation of ISOs.

Amending
ALEC

The proper
deregulatory mechanics will flow naturally from the
proper deregulation philosophy. Transmission is not a
natural monopoly; treating it as such impairs future
competition in the industry. State governments
forbiddance of full competition, not the utilities
control of generation, transmission, and distribution, is
the source of monopoly power. Exclusive territorial
franchises awarded by state public utility commissions
are much guiltier than any presumed natural monopoly
status of transmission and distribution.

ALEC should reject
the model bills regulatory core and set an example
by turning it into a model that will lead the national
restructuring effort down the right path.

Clyde Wayne
Crews Jr.

Senior Fellow in
Regulatory Studies
at the Competitive Enterprise Institute

The House Banking
Committee reported on 20 June, by a narrow 28-26 vote,
legislation that would effectively repeal the 1933
Glass-Steagall Act that separates commercial banking from
investment banking. The legislation also would force
thrift institutions to obtain a commercial bank charter;
permit the integration of banking, insurance, and
securities activities; and even allow some mixing of bank
and commerce. A major impetus for reform came last year
when the Comptroller of the Currency approved a
procedural regulation under which banks could seek
permission to offer non-bank financial services. But
interest-group politics and turf battles between
regulators could bog down this legislation, continuing to
saddle the American economy with a less-than-modern
financial system.

Changing
Structures

Government
regulation of banking and financial services is
notoriously complex. Under the Bank Holding Company Act,
any corporation wishing to own a commercial bank that
takes deposits and makes loans must register with the
Federal Reserve Board as a bank holding company (BHC).
BHCs in turn can own one or more banks but corporate
ownership of BHCs is highly restricted. For about a
decade, BHCs have been allowed to establish so-called
Section 20 subsidiaries that are allowed to underwrite
and distribute securities. Thus the Glass-Steagall
separation of investment from commercial banking has
already eroded significantly. The Comptroller charters
and regulates national banks; the states also charter
banks.

Federally chartered
savings and loans are regulated by the Treasury
Departments Office of Thrift Supervision. An
S&L can be owned by any other enterprise. The
Securities and Exchange Commission regulates many
activities of securities firms. And insurance companies
are regulated by the states.

Interest
Group Battles

While many banks,
securities firms, and insurance companies agree that
Congress should permit a full integration of financial
services, they do not agree on how to do it. One proposed
regulatory reform would allow commercial banks to offer
insurance services. But independent insurance agents fear
such competition. They want state insurance regulators to
regulate all insurance sales activities, believing that
state regulators will create a "level playing
field." Specifically, the independent agents want
all insurance agents, whether independent or working for
banks, to be subject to state regulation. Further, they
want states to limit the degree to which banks can tie or
bundle their insurance offerings with other financial
services. By contrast, banks want the Comptroller to
regulate the insurance sales activities of banks to
ensure that state insurance regulators do not
discriminate against banks.

Securities brokers
oppose commercial banks underwriting or trading
securities directly. They argue that banks that take
deposits insured by the federal government would have an
unfair advantage. Commercial banks, argue the brokers,
should be restricted to offering securities through
separate, Section 20 affiliates.

Regulatory
Turf Fights

While interest
group differences will have to be worked out if financial
services modernization is to garner the political support
necessary to proceed, the bigger battle is between the
regulators themselves. The Fed contends that if
securities firms and insurance companies want to own
banks that are "large enough to induce systemic
problems should [they] fail," they should be
required to register as BHCs and be subject to Fed
regulation. Not only do insurers and securities firms
object to "umbrella supervision" by the Fed,
but the Securities and Exchange Commission also strongly
objects to the Fed taking on the role of top dog among
the financial regulators.

The finalization
last fall of the Comptrollers so-called
"op-sub" regulation further complicates the
situation. It opened the door for commercial banks or
their subsidiaries to engage in activities that today can
only be engaged in by non-bank sub-sidiaries of BHCs. In
effect, the new regulation fosters the eventual emergence
of universal banks which could then shed their holding
company structure and Fed regulation while engaging in a
broad range of financial activities, presumably including
securities and insurance underwriting. Although banks are
moving cautiously in applying for new powers under the
op-sub regulation, it potentially gives banks a one-way
street into the rest of the financial services industry.
Further, most bank CEOs believe that the universal bank
structure offers greater management flexibility and
efficiency than the holding company structure.

Understandably,
non-bank financial firms object to the possibility that
banks may be able to escape the Fed regulation to which a
non-bank firm would be subject if it owned more than a
small bank. The Fed is fighting hard to keep banks within
its regulatory domain. It argues, incorrectly, that
deposit insurance constitutes a subsidy to commercial
banks. Further, it asserts that the holding company
structure will minimize leakage of the subsidy to
non-bank activities which would place securities and
insurance firms at a competitive disadvantage.

The Fed also claims
that because it is uniquely empowered to provide
practically unlimited funds to resolve any financial
crisis that might erupt, it must have continuous
oversight over any financial firm to which it might lend
in a crisis. Contrary to nearly universal belief, though,
the Fed is highly constrained in how much it can lend in
a crisis.

Another issue that
provokes interest group and regulatory infighting is the
proposed reform to allow greater mixing of banking and
commerce, that is, allowing commercial banks to own
substantial interests in other corporations and allowing
non-financial firms to own commercial banks. Companies
not linked to banks believe they would be at a
competitive disadvantage. But commerce has long mixed
with banking. Several score of thrift institutions are
owned by non-bank firms. Further, many individuals that
control commercial banks also have substantial
non-banking business interests.

Even the supposedly
easy task of melding the commercial bank and thrift
charters is running into problems. First, that issue has
been subsumed in the wider debate over the mixing of
banking and commerce. Second, thrifts increasingly see
advantages to keeping a separate charter. And third, many
commercial banks fear that modernization legislation
could actually curtail some of the freedom they recently
gained under the Controllers new op-sub regulation.

Overtaken
by Technology

These modernization
efforts are proceeding against the backdrop of
technological changes that make the current regulatory
regime unworkable. Technology is making it increasingly
difficult to neatly compartmentalize banking, insurance,
and securities products. Despite Congressional
sluggishness, though, universal banking, one-stop
financial services for consumers, and a more efficient
financial system are starting to develop.

What should emerge
from the modernization debate is not an industry sliced
vertically, with a regulator for each of the traditional
financial services industries. Rather, financial
institutions should be free to offer whatever financial
services they wish. There will be issues to resolve
concerning protection for depositors, insurers, and the
payments system from insolvent institutions or systemic
crises. No doubt there will not soon be the kind of
complete overhaul of the deposit insurance system that
some reformers might wish. But Congress will truly harm
America if it does not enact reforms that allow this
country to have an integrated and efficient financial
services sector for the 21st century.

Bert Ely

President, Ely
& Company Inc.

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